In this blog post, we explore the legal complexities of seller financing in M&A transactions, with a focus on a case involving a Boise-based graphic design company. The post examines the risks sellers face when accepting deferred payments like promissory notes, earnouts, and other contingent arrangements. A court ruling reveals how these financial structures can leave sellers exposed to the mismanagement or nonpayment risks of the buyer, particularly in bankruptcy scenarios. The post provides practical insights for sellers to safeguard their interests in such deals through strategic clauses and protections.
M&A Stories
January 31, 2025
Seller financing in M&A transactions can leave sellers exposed to the risk of buyer mismanagement and potential nonpayment. In one case, the sole owner of a Boise-based graphic design company sold her stock to a buyer and agreed to finance a significant portion of the purchase price via a promissory note. The note was secured by a pledge agreement that provided her with 100% voting rights until the note was paid off. However, the buyer defaulted on the note, and as the CEO and sole director of the company, filed for bankruptcy in Idaho.
The seller argued that the bankruptcy filing was unauthorized, given that she, as the holder of all shareholder voting rights, should have been consulted. But the court ruled that the directors—who, in this case, was the buyer acting as the sole director—had the authority to file for bankruptcy under Idaho law.
This case highlights the inherent risks for sellers who accept significant deferred payments, such as seller notes, earnouts, or other contingent payments. These financial arrangements often depend heavily on the buyer’s ability and willingness to effectively manage the business post-acquisition. In this instance, the buyer’s failure to fulfill the terms of the deal left the seller with no recourse.
The key takeaway for sellers is that deferred payments tied to future business performance, while appealing, can be precarious if the buyer mismanages or undermines the business. To mitigate these risks, sellers should consider incorporating protective clauses into the deal. These may include requiring regular financial reporting, providing consent rights over major decisions (such as bankruptcy filings), and placing restrictions on cash distributions. By anticipating potential challenges and structuring deals with these protections, sellers can reduce their exposure to risk in M&A transactions.
See: IN RE MURIE GRAPHIC DESIGN INC.., Case No. 24-00419-NGH, United States Bankruptcy Court, D. Idaho, (January 23, 2025).
Thank you for reading this blog. If you have any questions, insights, or if you’d like to engage in a more detailed discussion on this matter, I invite you to reach out directly.
Feel free to send me an email. I value thoughtful discussions and am always open to connecting with business owners, management, as well as professionals who share an interest in the complexities of M&A law.
By John McCauley: I write about recenegal problems of buyers and sellers of small businesses.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Podcasts https://www.buzzsprout.com/2142689/12339043
Check out my books: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles and Selling Assets of a Small Business: Problems Taken From Recent Legal Battles
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